Sunday, January 14, 2018

Price Trends, Clues and Concerns - Weekly Blog # 506


Bonds, stocks, and commodity prices are sending different clues while the pundits proclaim synthesized global economic growth. After thirty-six years of rising returns for fixed income, almost a decade of stock market gains, and commodity prices entering a new cycle, thoughtful market participants are confused. The one common impetus is growing confidence in decision-making. With more confidence investors are consciously or not accepting more risk because they are getting a somewhat clearer view of the future. As a contrarian, and often allergic to popular views, I have my doubts. I am not totally alone. Ian Bremmer of the Eurasia Group has said, “2018 feels ripe for a big unexpected crisis." My concern is that the growing confidence is crowding out a reserve for surprises, good or bad.

Inverted Yield Curve Fear

While it is true that the last seven fixed income prices declines came after the 2-10 year US Treasury yield curve inverted, I do not believe it is an immutable law of investment science. Nevertheless, it is a proper place for study. There is a similar pattern in the futures market when near-term investments are more expensive (higher yield) than long-term ones. What is important is that the market view is that the near-term future has more risk than the longer-term. Often this is right, but not always. Remember the surprise factor. In my opinion an inverted yield curve if and when it happens is more descriptive of current fears than predictive of long-term prices. Fixed income prices are set by supply and demand and are similar to the odds posted by book makers which are not the result of careful analysis but prices that will bring new bets into balance to keep the bookmakers’ capital risk into reasonable balance. The bookies and the bond market will lose out only if there are too many surprises.

The fears that there are oncoming inverted yield curves or other causes for bond prices to decline have been operating for the last few years. The biggest concern is not credit losses, but inflation. To service those who are concerned that inflation will rise above current levels, the US Treasury and others have created TIPS (Treasury Inflation Protected Securities) funds which are issued in roughly the same maturities as the other treasury paper. For more than the last three years the total return investment performance of the average TIPS fund is slightly better than the average intermediate US Government Securities fund. For longer periods the reverse is true. One wonders what the relative performance results would be when the reported inflation rate finally reaches or exceeds the Fed desired 2% level. It is possible that our and others are from time to time paying premiums to buy inflation protection and this is why the TIPS funds perform better rather than their pricing mechanism?

If one is managing retirement capital accounts for those that are currently working, I would substitute 30 year treasury yield for the 10 year. (More on this later.) 

Individuals investing in fixed income securities or funds should separate the total return numbers between income (interest) payments and market prices. Inflation will not nominally impact the income stream, but may have significant impacts on both the prices of the bonds and the purchasing power of the proceeds.

At Caltech and other places studying how the brain makes decisions, they have found that most humans make decisions on finding past memories that coincide with current conditions. Every now and then, the occasional winner will see the current situations as sufficiently different than the past that they opt for a new strategy. In other words the preferred algorithms will give way to new thinking and actions.

Stocks Are a Confidence Game

Almost every prognostication from brokers, advisors, and commentators in terms of the stock market were expansive. Two recent examples display the enthusiasm for the stock market are as follows:

  • Extrapolating the first full trading week suggests that the S&P500 will triple this year.

  • Goldman Sachs believes that the Bull market should run for another 3 years.

  • “Investors Intelligence” tracks letter writers in its latest report in Barron’s; 64.4% are bullish and only 13.5% are bearish. In approximately the same period the AAII weekly survey showed a significant reversal in their volatile report with the bulls declining to 48.7% from the prior week’s 59.8% and more significantly the bears gained to 25.1% from 15.8% the prior week. The AAII sample shifts each week which could have caused the changes and this week some were more worried about the impact of the bond market or were reaching to political news.

    Commodities are Active

    Based on perceived increasing demand from China and rising demand from US manufacturers, industrial metal prices are rising. In a classic example of a surprise, the price of oil touched $70 a barrel this week and there is a press story that some expect the price to reach $80 this year. In response, over the last four weeks the best performing mutual fund investment average is the Natural Resources funds, up 12.66%. As a contrarian and a long-term investor I am wondering when the increasing population and shrinking farming land will be seen in rising prices for grains. This hasn’t happened in a long time.

    Very Long-Term Outlook

    The latest available estimate of the global retirement savings gap in 2015 was $70 trillion and by 2050 it is estimated to be $400 trillion. Thus, in only 35 years there is a need for over five times more capital to be invested for retirement. (This is why I suggested using the 30 year yield for the spread calculation.) How should one invest to meet this long-term need? I do not believe that today one can evolve a consistent investment policy to meet these needs. My contrarian nature suggests that it may be easier to identify what not to do. The average S&P500 mutual fund beat 90 out 96 mutual fund investment averages for the last five years and 84 for the last ten years. I don’t think that will continue. The best performing hedge funds in 2017 were invested in large caps and securities driven by momentum (FAANG + 2 from China).  Different strategies at different times will be needed to avoid losses and achieve gains. This is why I believe that a portfolio of different funds or managers is the most prudent for the long-term.

    Question of the week: What are the most prudent strategies for the long term?

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    Sunday, January 7, 2018

    Reluctant Excuses: TINA to FOMO;
    Good News: Historical Trends to Apple Store;
    Accelerating Momentum: Incomplete - Weekly Blog # 505

    Introduction to FOMO

    Changing sentiment appears to be a much stronger force than earnings taking the stock market higher. A couple of years ago, investors reluctantly were buying equities in the face of expected rising interest rates, relatively slow earnings growth, and expected political turmoil. Their excuse for this questionable decision was TINA, There Is No Alternative. Over the last fourteen months this excuse has given way to another symbolic abbreviation FOMO, Fear Of Missing Out. During these last fourteen months and the first week of January, 2018, the S&P 500 has not had a single month decline. Momentum has become the mantra for the buyers as well as the larger audience of holders. In the last calendar year the leading investment performance factor within the S&P 500 universe has been the momentum stocks that gained 28.27%.

    Will it Continue?

    This week we had two very insightful experts publish their views of the year ahead with clues beyond. Byron Wien published his annual ten surprises that he believes have at least a 50% chance of happening and that his wide circle of global contacts believe have less than a 33% of happening. One of his surprises is that the market will take a 10% correction during the year. He thinks that a recession will not surprise us until at least 2019.  Further he recognizes that there may well be other surprises during the year that none are expecting. Nevertheless, one could interpret his views that stocks markets in general will be well behaved.

    The second very worthwhile piece published this week was by Jeremy Grantham of GMO. Jeremy by nature tends to be on the bearish side. Thus it is a bit surprising that he entitles his piece “Bracing Yourself for a Possible Near-Term Melt-Up.” While he does acknowledge that we could have a 20% decline that he believes would be helpful, he also does not see a near-term recession. Like Byron he sees the S&P 500 as going well into the 3000 territory. B/t/w, his firm has an equity fund that is among the leaders in the institutional league.

    The odds are that these two gentlemen will prove to be correct and I hope so. However, when I mention odds I am force to think of the lessons that my experience bought at the major New York racetracks which can be briefly summarized as follows:

    1.  Past performance is good to organize one’s memory, but can be less useful in predicting the future.
    2.  Each race (Market) is different with different horses and conditions.
    3.  Different odds lead to different earnings.
    4.  It is not the number of wins that counts, but the size of winnings taken away.
     5.  As a contrarian one can win more money by occasionally betting against the crowd.

    Good News: Historical Trends to Apple Store

    One of the reasons to own rather than loan is that over long periods of time human life is generally getting better. Most of the time we don’t get this message from our political leaders and their supporting pundits. If there weren’t problems to be addressed we might not tolerate governments and their expenses. Thus, we do not see a lot of publicity about the long-term progress we have made some of which from an article by Max Roser can be shown below:

    ·       Since 1990 there have been 130,000 people fewer in extreme poverty every day.
    ·       Globally in 1800 there were fewer than 100 million that could read. Today 4.6 Billion can read.
    ·       In 1800, 43% of the newborns didn’t see their fifth birthday. In 2015 child mortality was down to 4.3%. Improved health and nutrition has made us taller and smarter.
    ·       These and other positive trends are continuing and accelerating.

    Part of the reasons for this progress is due to technology which marches to its own drummer. Technology itself is driven by the desire for increased profit. I refer to profit not in an accounting or monetary sense, but a desire to improve one’s own life, often to improve the lives of ones for which the individual cares.

    This thought occurred to me this weekend when I accompanied my wife to the Apple Store at The Mall at Short Hills. It was by far the busiest store in the mall with both customers, salespeople, support staff, and in effect, trainers. It only took a little more than an hour to exchange her watch for a different model and synchronized it with her iPhone. During that time I had a chance to look at a very diversified group of customers waiting patiently to be served and an equally diverse sales and service group on a packed sales floor. 

    What occurred to me is that we were experiencing an ecosystem which is building loyalty and a knowledge base both for customers and a helpful, well-trained sales force. In many ways each person in the store was looking for ways to improve his or her condition in a personally profitable way. (The visit made me happy that I have been a very long-term shareholder in Apple and reinforced my faith in their eco-system in spite of periodic hardware and software glitches.) 

    The potential of Apple and its good competitors to deliver very useful products and services addressing many of our unmet needs suggests to me the rate of human progress will accelerate in the years ahead and will probably benefit my grandchildren, great grandchildren and their children.
    Accelerating Momentum: Incomplete

    In a market that relies on sentiment to drive its momentum, one can not wait on published financial and economic results. One should be paying attention to what consumers at all levels and investors are doing as well as saying. Recently I have been commenting on the AAII weekly survey of a sample of its members. As I have said previously, a normal distribution of the individuals' opinion is roughly 40% bullish and 30% each for neutral and bearish. This week the bullish reading exceeded 59% and the bearish number was about 15%.Two weeks ago the numbers were 50% and 25% respectively. Clearly a symptom of accelerating momentum

    The siren of the rising stock market has not sucked in all the available money that is fearful of missing out. The banks (particularly the small and regional banks) have not lost cash deposits to the stock market. As a matter of fact, this week the average money market account dropped its rate to 0.30% from 0.33% the week before. The drop may be caused by less demand for loans or possibly that some banks were bulking up their cash items for year-end statement purposes.

    Some market observers and I are carefully watching the yields on treasuries. Each major stock market decline had rising yields as money sought safety away from actual or perceived credit risks. Some feel a ten year yield above 2.50% could be alarming.

    What to Do?

    If economist Jeremy Grantham is correct that we are in a “melt-up” and there will be a 20% decline before the eventual recession which could trigger a bigger decline one may want to shift some of one’s equity positions into highest available quality. That would not have hurt you too badly in 2017 when the quality component in the S&P 500 gained 19.51%.

    At this time large market caps with reasonable balance sheets yield above the ten year treasury. Not a great deal of actively managed investors and high market liquidity can be used as bond substitutes. Because we can always be surprised I would own a bunch of these. They may include AT&T, GM and GE plus a few others. If one becomes addicted to investing in quality stocks for the long run, there are more in the small cap arena than elsewhere, but these are for investing not cyclical trading.

    Question of the Week: Do you agree or disagree with my analysis?     

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    Monday, January 1, 2018

    Keys to 2018: Sentiment, Surprises, and Confidence - Weekly Blog # 504


    William Shakespeare’s three witches in Act IV of Macbeth may have been one of the first to warn of bubbles when they chant “Double, double, toil and trouble; fire burn and cauldron bubble. (emphasis added). This prescription is a warning to me. I manage one account that is not being offered, starting in 1999 and is up 3.39 times original cost closing in on double, double.

    Are we headed for trouble on the way to a bubble? Further, worth noting is that there are a number of SEC registered mutual funds that have doubled this year. Even some mutual fund averages have gained about four times a normal year’s gains with twelve separate fund peer groups rising  44.61% to 30.29% up to the penultimate day of the year. (The last that was available at this writing, the final day did not show much movement.)

    The above mentioned trouble could be that driving these funds’ performances is about ten global tech equities. Typically at the top of many markets there are only a few leaders enjoying outsized gains.

    In Shakespeare’s play it takes some time and plot development from the witches’ chant to fulfill their prophesy. Thus, it may take some future market developments for a similar fulfillment, or it may not happen. The way I track the route to an eventual peak is through watching sentiment, surprises and confidence indicators.


    In its weekly poll of the sample of members, the American Association of Individual Investors (AAII) as published weekly in Barron’s, divides  its views into Bullish, Bearish, and Neutral. For the last two weeks this very volatile poll is showing over half of the respondents are bullish. Typically the split to the leader is more likely to be in the high 30% to low 40%.

    There are many different ways to measure sentiments of investors in aggregate. To me the most useful lens is to look through the changes in valuation. Prices currently show what investors are willing to pay for various elements of fundamental data, dividends and interest; reported operating and GAAP earnings; reported and adjusted book value; among others. Currently with the stock market prices going up at a faster rate than announced and/or analyzed results, there is an increasing amount of optimism. Merrill Lynch has labeled 2018 as the Year of Euphoria. (I hope it is just a year of increasing optimism which normally leads to a normal price decline. Bouts of euphoria are rarer and lead to major market turning points that create subsequent, substantial declines to a lower level than when the rising stock market began.) Merrill and most of the investment world is cheering on the rise in various economic statistics with the belief that the best is yet to come. 

    Better news and higher projections are increasingly being valued more highly. In most cases these are in the upper regions of their historical time series, but not yet setting new high watermarks in valuations. Traditionally auto analysts and some industry economists (after a particularly strong automotive sales year) worry that a great year brings forward demand from future years. When those succeeding years' occur they would be significantly below the normal sales trend line and produce a pro-cyclical rather than a continuation of the pro-growth periods.

    Part of the problem of creating unsustainable peaks is that global political leaders are attempting to push job creation policies as measured by labor productivity. We may be entering a period of over-hiring because it is too difficult to find the right workers with appropriate skills and good job attitudes and discipline, thus we may soon be entering a job hoarding phase. Instead of focusing on the relatively small number of unemployed and under-employed, we should be looking essentially for higher consumption productivity. More people would benefit for higher quality products and services where increased demand leads to slower price increases and better service for consumers.

    Near-term rise in sentiment is anticipatory of better future results, but probably can not be sustained as we fill the demands of consumers for goods and services at reasonable prices and quality. As sentiment normally follows an accelerating curve rather than a normal trend line, with the gains created it also creates a risk as to when it reverses a fall at a faster rate than in its acceleration phase. Enjoy, but be prepared.


    Shortly my good friend and former member with me on the board of the New York Society of Security Analysts, Byron Wien, will publish his annual list of at least ten surprises. For a condition to make the list its possible occurrence must be disbelieved by the majority of the professional investment community. Byron has a good batting average with over half of his “surprises” turning out to be accurate. 

    I recognize that there will be surprises that most of us don’t anticipate. These can be positive or negative surprises. In terms of impact, with sentiment rising and therefore accepted, the upside is likely to be less than the downside surprises. 

    Many of the financial media and other pundits focus much of their attention on the US. Clearly, there will be some US-centric surprises that will move the market. However we can not avoid being a consumer and investor in the globe.

    I suspect that some of the most impactful surprises will come from Asia, the Middle East, Africa and Latin America. The interesting thing about the initial market movements upon the discovery of the surprise will be reversed subsequently. To me the key to these surprises is that we are not sufficiently paying attention to areas and subjects.  One somewhat overlooked opportunity caused by a surprise is often a chance to be on the other side of the reaction trade, buy when others are selling without price discipline or supplying to the market when there is excess enthusiasm. As sentiment rises, playing surprises could be a good tactic.

    Based on many of the past large stock market declines, the biggest surprise is likely to be in credit creation. Some actual or rumored credit user or groups of users at an instant in time may be deemed unable to repay their debt and/or interest, and could cause a sharp drop in the stock market in more than one country. Credit like money is fungible. When credit  is withdrawn it creates a vacuum which is answered by rapid shifting of credit support to, at that time, the most credit-worthy borrowers. One way or another equity markets ride on a sea of credit to earn a rate of return in excess of interest rates charged.


    One should not equate confidence with sentiment. Based on political history and my experience at the racetracks, in only a minority of the cases do they come to exactly the same conclusion at the same time, but they do every once in awhile. One of the better measures of confidence is to examine the age and experience of the most confident players and pundits compared with the least. Most people that are confident of the result have no idea how their confidence will actually work out. They don’t understand the tactics and mechanics of what will happen after the victory celebration.

    Current View

    The larger level of enthusiasm by people/investors who are not experienced, the closer we are probably to a significant change in direction, but as Saint Paul pleaded with God, “Not yet.”     

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    Copyright ©  2008 - 2018

    A. Michael Lipper, CFA
    All rights reserved
    Contact author for limited redistribution permission.